Weekly Forex Currency Review 11-11-2011

The Euro-zone debt crisis has again dominated the headlines with the surge in Italian yields fuelling speculation over a break-up of the Euro-zone and fears over a global credit crunch.  Ironically, capital repatriation fears could continue to support the Euro initially as will speculation over a long-term smaller and stronger Euro area. High volatility is likely to be a key feature.

Key events for the forthcoming week

Dollar:

The dollar will tend to be dominated by international considerations in the short-term and there will be some defensive demand for the US currency, especially with increased Euro-zone fears. There will also be fears over a flow of funds out of emerging markets which will underpin the dollar. Underlying confidence in the US economy will remain fragile and there will be only limited fundamental support given the underlying growth vulnerabilities. There will also be fears surrounding the budget outlook, although the relative merits should see the dollar maintain a solid near-term tone.

The dollar advanced against major currencies during the week as risk appetite deteriorated again. There was also a flow of funds out of emerging markets which underpinned the US currency, although there was also still an underlying lack of conviction in the moves with Euro support on dips to below 1.35.

There was little change in the latest consumer confidence reading while regional Fed Presidents Plosser and Kocherlakota again voiced concerns over the Fed’s guidance on future policy, although there was less concern over the current policy stance.

The subsequent US economic data was slightly better than expected with jobless claims falling to 390,000 in the latest week from a revised 400,000 previously while there was a narrower than expected trade deficit of US$43.1bn for September from US$44.9bn as exports pushed to record levels. The data will maintain a slightly more hopeful tone towards the US economy.

Defensive considerations will remain extremely important and there will be dollar demand on fears over the Euro-zone and global economy. Fears surrounding emerging markets could be particularly important in supporting the dollar.

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Although the Greek situation remains very serious, it has been overtaken by the developments in Italy, especially as the bond market is extremely important in global terms.  There will be substantial fears over the Euro outlook and there will be strong pressure on the ECB to increase Italian bond purchases or for the German government to make moves towards fiscal union. There will be strong political opposition within Germany and there will be further market speculation over a break-up of the Euro area.  There will be fears over a credit crunch which would ensure recession. Speculation over a smaller Euro area will provide important Euro support at times with volatility liable to remain extremely high.

The Euro was subjected to very heavy selling pressure on Wednesday as the situation in Italy deteriorated rapidly. There was a surge in Italian bond yields during the session as Prime Minister Berlusconi’s resignation promise failed to boost investor confidence. Benchmark yields rose through the 7.0% level, a pivotal area which helped trigger rescue packages in Greece, Portugal and Ireland.

Italy is the third largest global bond market and a huge financial commitment to stabilise conditions would be required. The EFSF is very unlikely to have sufficient resources even if it can secure additional leverage. This development will put strong pressure on the ECB to increase its bond purchases through quantitative easing.

Given these pressures, there was also increased speculation that the Euro-zone governments would be forced to consider much more radical solutions. There would either need to be a full-scale commitment to fiscal union or a move to create a narrower Euro-zone. This speculation was fuelled by media reports that Germany and France have been working on a plan for a scaled-down Euro area for months.

There was sufficient demand at the latest Italian auction even though yields increased to a 14-year high and rose sharply from the previous sale in October and this did provide some relief late in the week with the Euro recovering ground.

There was further strong rhetoric from ECB and Bundesbank officials opposing any extension of the ECB bond-buying programme. Officials, including Euro-group Head Juncker, continued to insist that there could be no expulsions from the Euro area.

The Euro-zone economic data offered no support with the Sentix investor confidence indicator weakening to a two-year low while there was a 0.7% decline in retail sales for October.  There was also a 2.7% slide in German industrial production and the EU Commission cut the 2012 growth outlook sharply to 0.5% from 1.8% previously.

The Greek President announced that a new government would be sworn in on Friday under Papademos and there was a commitment to maintaining the austerity programme, although confidence was inevitably very fragile, especially after protracted delays in forming an administration.

Yen:   

There will be continuing fears over the Japanese growth outlook, especially if there is a downturn in Asia as a whole.  The Bank of Japan will remain an important focus in the short-term and there will be speculation over further central bank intervention. The yen will, however, continue to gain defensive support from a lack of viable alternatives, especially with the Swiss National Bank determined to block any renewed franc appreciation. There is also the potential for capital repatriation which will limit the scope for yen depreciation.

The dollar was unable to make any impression on the yen and retreated back to test support in the 77.50 area despite slightly stronger than expected US data with yen selling still limited. There was still little underlying interest in selling the Japanese currency, especially given the lack of viable alternatives. There were renewed warning from the Swiss National Bank over the franc’s level and this encouraged some flow of funds into Japan as an alternative to the Swiss currency.

Overall confidence surrounding the global economy and risk appetite remains extremely fragile and this is maintaining defensive demand for the yen, especially with a lack of viable alternatives. Official comments on the yen will continue to be watched closely given the possibility of renewed intervention and these fears will certainly tend to slow any yen advance.

There was a weaker than expected reading for core machinery orders which fell 8.2% for October following a 11.0% increase previously and confidence in the Japanese growth outlook remained weak even though it is a volatile series.

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There will be further concerns over the UK economy as domestic conditions remain extremely difficult. There will also be fears that the Euro-zone crisis will have a negative impact on growth.  There will be pressure for the Bank of England to embark on further quantitative easing which will reinforce the lack of yield support. There will still be scope for further near-term defensive inflows into the UK currency as a refuge from Euro-zone fears. The banking sector will remain important and there will be some concerns surrounding the threat of capital outflows which could also have a negative impact on Sterling.

Sterling advanced to 8-month highs beyond 0.85 against the Euro and was resilient against the dollar just below 1.60 even though it was unable to make any headway.

The latest trade data was worse than expected with a goods deficit of GBP9.8bn from a revised GBP8.6bn the previous month as exports were subdued and import demand increased. The data will increase fears over a downward revision to the third-quarter GDP data. In contrast, the NIESR estimated GDP growth of 0.5% in the three months to October, unchanged from the previous estimate which suggested that demand within the economy had not dipped very sharply at the beginning of the fourth quarter.  

The Bank of England left interest rates unchanged at 0.50% following the latest policy meeting and also left quantitative easing on hold at GBP275bn. Markets will have to wait for the minutes to discover whether any members proposed additional stimulus.

There was still some evidence of defensive flows into Sterling as UK bond yields remained at extremely low levels in historic terms. There will still be concerns that banking-sector assets could be withdrawn to help underpin European balance sheets and this could expose Sterling to heavy selling pressure if market sentiment shifts.

Swiss franc:

The National Bank will remain determined to protect the minimum Euro level against the franc with further strong verbal intervention. Euro-zone trends will be watched very closely and any further increase in contagion threat could still result in capital inflows and pressure on the franc. There will be the threat of further market volatility which will complicate the National Bank’s task, although it should be able to maintain the situation in the short-term with a reluctance to take an aggressive stance on buying the Swiss currency.

The franc weakened against the Euro for the week as a whole despite some strengthening in mid week and the Swiss currency also lost ground against the dollar with lows beyond 0.91 as domestic protests over the currency’s level continued.

National Bank warnings continued with comments that the minimum Euro level would be defended aggressively and that the franc should weaken further given that it is still substantially over-valued. The remarks were tempered by comments that the bank was not pursuing a policy of competitive devaluation.  

The latest consumer inflation data was weaker than expected with a 0.1% decline in prices for October with the annual rate also at -0.1%. Although the franc has weakened, the data will increase market unease over deflation and increase Bank determination to prevent further renewed gains.

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The Australian dollar was unable to make significant headway during the week and was subjected to heavy pressure as Italian fears intensified with lows below 1.01 against the US currency before a tentative rally. Risk conditions remained extremely important for the currency and there were further fears surrounding the global outlook as Euro-zone fears intensified.

The domestic data provided some support for the currency with a small decline in the unemployment rate and a rise in employment of just over 10,000 for October. There was also a rise in home loans which eased immediate fears surrounding the sector.

Australian dollar volatility is likely to remain high and there is the threat of renewed losses given the underlying risks, especially if banking-sector fears increase.

Canadian dollar:

The Canadian dollar hit resistance on gains to beyond the 1.01 level against the US currency and dipped to lows beyond 1.0250, although there was solid buying support on dips.  There were further stresses surrounding risk appetite in the short-term which undermined the currency, but the impact was offset by resilience in commodity prices.

The currency also benefitted from underlying confidence in the economy despite unease over the global economic outlook. The Bank of Canada’s inflation mandate was left unchanged following parliamentary review.

The Canadian dollar will be vulnerable to some further selling pressure given the global risk conditions, but should prove to be broadly resilient.

Indian rupee:

The rupee was unable to gain any significant traction during the week as international conditions remained generally unfavourable and there was a test of support beyond 50 against the US dollar. Risk appetite deteriorated as Euro-zone fears increased and there was also increased unease over the risk of capital outflows.

There was evidence of strong dollar buying by oil importers and there were also concerns over the economy as the trade deficit widened to a 4-year high according to the October data.

The rupee trends will continue to be influenced strongly by trends in risk appetite.  The currency will find it difficult to secure more than a limited recovery.

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The Hong Kong dollar was unable to secure renewed gains during the week and retreated towards the 7.78 area against the US dollar, although losses were still limited.  Risk appetite was generally weaker which curbed demand for the local currency and there were still doubts surrounding the Chinese economy.

HKMA chief Tsang reaffirmed the determination to maintain the current peg against the US currency.

Risk conditions will sap support, but the Hong Kong dollar should remain resilient with medium-term support from speculation over a peg revaluation.

Chinese yuan:

The yuan was unable to make any headway during the week and the spot rate was generally trapped close to the 6.35 area against the US currency. As far as the economic data was concerned, there was a sharp slowdown in inflation according to the latest data with a rate of 5.5% for October which maintained some expectations that the PBOC would move towards a looser monetary policy.

There was also weaker export growth according to the latest data which increased doubts whether there would be medium-term yuan appreciation, especially with concerns surrounding the outlook for bad loans.

Volatility is likely to remain higher and speculation surrounding an easier monetary policy will also limit the scope for appreciation in the near term.